India

India's Misguided China Anxiety

India’s growing trade deficit with China—an estimated $27 billion in 2011—has become a source of anguish in Indian policy circles. Bilateral trade between the two emerging giants grew to $73 billion in 2011, up from $63 billion in 2010 and less than $3 billion in 2000. The Indian side, though, is becoming increasingly alarmed over the growing trade balance in China’s favor, which amounted to a Chinese surplus of $23.9 billion last year.

In December, India’s National Security Council Secretariat, the apex agency responsible for economic and strategic security, even circulated a note to various ministries detailing its concerns and backing a possible move by the country’s Department of Commerce to start restricting imports from China. Unfortunately, much of the public discussion on this subject has tended to be shallow. Few people seem to understand the trade deficit’s underlying causes, its implications for India’s economy, and what India should do to create a better balance.

There’s no question that India’s overall merchandise trade deficit is soaring, growing from $13 billion in 2000 to $103 billion in 2010 and an estimated $150 billion in 2011. At more than 6 percent of the GDP, India’s trade gap is huge. The trade deficit has grown even though India over the past 10 years has been the fastest-growing exporter among the world’s top 10 economies. From 2000 to 2010, India’s exports grew at an annual rate of 19.3 percent—more than twice the rate of the 9 percent growth in world trade and about the same as the 20.1 percent average annual growth in China’s exports.

Even if the trade deficit with China were magically to vanish, it would do little to address the country’s trade imbalance. The deficit with China accounts for less than 20 percent of the country’s total trade deficit, with India importing Made-in-China toys, consumer electronics, telecommunications gear, and power equipment. More damaging to India’s trade numbers, though, is the reliance on imported oil, gas, and coal from such places as Saudi Arabia, Iran, Australia, and Indonesia. Energy accounts for more than 65 percent of the trade deficit. In sum, the primary trade challenge for India is rooted in its rapidly growing need for energy coupled with the rapidly increasing price of energy resources.

Let’s now look at the underlying causes of India’s trade deficit with China. Children’s toys may be a highly visible symbol of China’s seeming invasion of India. They account for less than 1 percent, however, of India’s imports from China. Of China’s total 2010 exports of more than $40 billion to India, more than 60 percent came from capital goods, such as electrical machinery, nuclear reactors, boilers, iron and steel products, ships and boats, and project goods.

Starting in 2007, India’s political leaders finally began a serious effort to address the country’s massive infrastructure deficit. This has meant rapid growth in investment in sectors such as power, telecommunications, ports, roads and highways. Since India’s domestic producers have been unable to keep up with the growing need for machinery and other capital goods, the country has no choice but to import equipment. With prices 30 percent or more below those offered by suppliers in the U.S., Europe, or Japan, Chinese companies have been the natural beneficiaries of India’s growing appetite for capital goods. India does have some things that China wants: India is one of the world’s largest producers of iron ore and cotton, and China is a major customer. Not surprisingly, as the world’s largest cotton importer, China has complained about India’s recent moves to ban cotton exports. Given pressure also from India’s cotton farmers, the government has now decided partially to reverse the ban.

With a less competitive manufacturing sector, though, India cannot hope to export large volumes of manufactured goods to China. India is much stronger than China in information technology (IT) and IT-enabled services. Given Indian providers’ fluency in English and not Mandarin, however, there is very limited scope for India to export such services to China.

What would happen if the Indian government were to restrict imports of Chinese capital goods into the country? Yes, the trade deficit with China would come down, but the country’s overall trade deficit would become even bigger. To see why, look at the $8.29 billion order that India’s Reliance Power placed in 2010 with Shanghai Electric to supply equipment that would generate nearly 24 GW of electricity annually. (That’s equal to about a fifth of India’s total electricity production.) The agreement included a financing deal with a consortium of Chinese banks, such as Bank of China and China Development Bank, providing low-cost financing. If Reliance Power had purchased this equipment from non-Chinese suppliers, the price would have been a few billion dollars higher and the company would have faced difficulties figuring out how to pay for the purchase.

It would therefore be self-defeating for India to erect artificial barriers to imports from China. Nonetheless, as part of smarter engagement with China, India can and should pursue a number of policies. First, given unsettled border tensions and a fluid geopolitical environment, India should continue to emphasize national security issues. National security should not, however, become an excuse for artificial trade barriers.

Second, taking a page from China’s own industrial policies, India’s leaders should demand that Chinese companies wishing to remain major suppliers to Indian companies start manufacturing in India. As the size of India’s market for manufactured goods continues to grow, this would also become an increasingly attractive strategy for Chinese companies.

Third, India must demand reciprocity vis-à-vis market access. For example, consider the auto sector. Chinese auto companies are keen to go global and, outside of China, see India as the hottest and fastest-growing market in the world. With that in mind, India’s leaders should ask their Chinese counterparts why India should open its market to Chinese auto companies when China does not permit foreign auto companies interested in coming to China to take more than a 50 percent equity stake.

During the current decade, India’s top economic priority should be to keep pushing infrastructure buildup at a very aggressive pace. Imports of less-expensive capital goods from China, financed by low-cost capital from Chinese banks, help India accomplish this agenda at an accelerated pace. India’s labor costs are already cheaper than China’s. India’s engineering and management skills are also world-class. The sooner the infrastructure deficit gets addressed, the faster India will start to become more competitive than China on the manufacturing front. By exporting low-priced capital goods to India, China is helping to create an economy that will prove to be its toughest competitor by 2020. Maybe sooner.

Gupta is the Michel D. Dingman Chair in Strategy at the Smith School of Business, The University of Maryland and a Visiting Professor of Strategy at INSEAD. His most recent book is Global Strategies for Emerging Asia (Wiley, 2012). Wang is managing partner of the China India Institute, a Washington-DC based research and consulting organization. Gupta and Wang are also the co-authors of Getting China and India Right (Wiley, 2009) and The Quest for Global Dominance (Wiley, 2008).